I declared bankruptcy about 6 years ago and have posted here before about trying to work with Chase to reaffirm my (5.8%) mortgage debt at a lower interest. That's not possible, so my next step was to look at a refinance. It looks like I can get a lower interest rate by refinancing, but it's going to cost about $4,000 in fees. It seems like I could also accomplish almost a 4.5% interest rate by paying about $100 extra a month to my mortgage on my own, turning my remaing 23 years into a 15 year loan. And doing this would avoid $4000 in fees. I pay all of my bills each month, but my income is low and I'm not really making much progress at 20% interest on the $12k or so of debt that I owe. I have a 401k worth about $10k (vested) and I realize if I cash it in, I can expect the Government to steal 30%-40% of it in taxes. however, that would still leave about $6k to pay off debt and tip the tables enough so that I can dig out from under the interest on the cards. $10k earning a few percent each year in my 401K isn't going to do anything for my future, but if I could use $6k now to pay off 20% interest credit cards, I could eventually start saving money. I realize it'll cost me $4k, but so would a refinance on the house. And once I've got the debt down to $6k or so, I can manage it at a lower interest rate (by carrying it on a lower interest card). And when the credit cards are done, I can pay more towards prinicipal on the house. The flippant answer is always, "don't raid your 401K to pay off credit cards." But it really seems to make an awful lot of sense in this case and as long as I set aside $4k for the tax bill, it really seems like paying 40% to the government now is better than paying 20% compounded year after year to the credit card companies. Should I do this?
Financially, it's never a smart move to tap retirement funds to pay off unsecured debt, but if it'll make you happy, then perhaps it's the right move for you. How's your credit score? If it's good, you could always look at using a balance transfer card instead to give yourself 18 months or so to pay off as much of the $12K as possible. Perhaps another job for awhile, or sell something to pay off the credit card debt? By the way, how far are you away from retirement?
Basically right now what interest rate is your current mortgage at? And when looking at re-financing, are you looking to move your mortgage to a 15 year? When you've talked to them about the re-fi - what type of changes would you get with your mortgage payment? I'm asking these questions, because it is important to look at all factors when making the decision. Rather than actually cashing out your 401K, you might want to consider taking a loan out against it (the interest is actually paid back to your 401K, and the money removed is NOT TAXED - because you are just borrowing it so it won't show like taxes). Another thing is that you will be taxed MUCH more than your normal paycheck if you cash in your 401K - so you might actually only see about 55% of that. One thing you might want to run the numbers on would be this: 1) Borrow the 4K from the 401K to re-fi the mortgage at 30 years (to significantly reduce the monthly payments) 2) Transfer any of the high interest card's balance over to low interest cards 3) Pay only minimums on low interest card 4) Pay EVERYTHING you can to the high interest card until it is paid off 5) Then pay off the other cards - THEN when all your unsecured debt is gone, start paying significant extra money over to your mortgage. With the significantly lower mortgage payments, you will pay that high interest debt off faster.
If you're paying 20% on debt, you shouldn't think about paying extra on your mortgage to pay if off early. It's only at 5.8% and the interest is tax deductible. So first of all, if you have an extra $100 a month, pay it on the bill with the highest interest rate. All you extra money should go against the highest-rate debt. As Joshua said, it's really not a good idea to use your 401(K) to pay off debts. You lose the money you pay in taxes, and you lose the tax-deferred compounding of your funds. You will need to have money when you retire. Taking a loan against it is an option. But how about a second job, or finding someplace else to cut expenses? You'll be much better off in the long run.
Thanks so much for the responses. Joshua: Good suggestion about trying to use a lower interest card; but even with some free credit now, I'm not able to swing it. However, if I'm able to get half of my debt paid off, I think doing that with the other 50% will be a real option for helping me get it paid off quicker. Chris: I don't work a job with a 401k anymore, so I don't have the option of borrowing. However, even when I think about losing 30%-40% of the money, it's tempered by realizing that it's a 10% penalty, but eventually I'd have to pay 20% (or more) in taxes on it when I got it out. Hedwig: You're absolutely correct, I wouldn't try to pay down the mortgage now while I've got the higher interest debt. I do work over 60 hours a week, but the interest is eating me up. In the last year my 401k grew 4% (I checked), but I spent 20% on credit card interest for the same amount of debt. So over the next 5 years, I would spend $4700 in interest while I'm paying off $6k (of the $12k), and I would earn approximately $1800 from the 401k. If I take the 30%-40% hit on the $10k, I'm losing $3500 instantly but would be saving $4700. Seems like I'd be up $1200. And like Joshua suggested, with the open credit, I may get "introductory offers" and lower interest opportunities that would further make it worthwhile. Additionally, I'm protected against the bank jacking up the rate even more. I can dig out of the remaining $6k much more quickly, perhaps in as little as a year. And then within a year the money that would have gone to debt could grow me a $6000 nest egg. In another year, I could double it. Using the 401k now doesn't wipe out my ability to save in the future and compound interest on that money. It just delays that process a couple of years. Does my math look correct here?
